Banks vs. American People - Can Wall Street Reform Be Done?

[Guest LAW]

EXHIBITS

Hearing On

WALL STREET AND THE FINANCIAL CRISIS:

THE ROLE OF INVESTMENT BANKS

 

110. Goldman Sachs/ACA email, dated January 2007, re: proposed Paulson Portfolio (Of the 123 names that were originally submitted to us for review, we have included only 55.).

 

111. Goldman Sachs internal email, dated January 2007, re: ABACUS - Initial Draft Engagement Letter for ACA (What time works on the 5th to have a paulson discussion ....).

 

112. Goldman Sachs internal email, dated January 2007, re: GSC post (...GSC had declined given their negative views on most of the credits that Paulson had selected.).

 

113. Goldman Sachs internal email, dated January 2007, re: ABACUS Transaction - update (...Paulson has suggested we substitute GSAMP 06-HE4 M8 and GSAMP 06-HE5 M8).

114. Goldman Sachs internal email, dated January 2007, re: ACA/Paulson (...help Paulson short senior tranches .... *** Still reputational risk ....).

 

115. Goldman Sachs internal email, dated February 2007, re: ACA/Paulson post (My idea to broker the short. Paulson's idea to work with the a manager. My idea to discuss this with ACA who could do supersenior at the same time. . .).

 

116. Goldman Sachs internal email, dated February 2007, re: ABACUS 2007 AC1 – Marketing Points.

 

117. Draft Goldman Sachs Letter Agreement to Paulson Credit Opportunities Master Ltd., February 3, 2007.

 

118. Goldman Sachs internal Memorandum to Mortgage Capital Committee, dated March 12, 2007, re: ABACUS Transaction sponsored by ACA).

119. Goldman Sachs internal email, dated March 2007, re: ABACUS ACA (Paulson will likely not agree to this unless we tell them that nobody will buy these bonds if we don't make that change.).

 

120. Goldman Sachs, ABACUS 2007-AC1, $2 Billion Synthetic CDO, Referencing a static RMBS Portfolio, Selected by ACA Management, LLC, March 23, 2007.

 

121. Goldman Sachs, ABACUS 2007-AC1, LTD, Offering Circular dated April 26, 2007. (excerpt)

 

122. Goldman Sachs internal email, dated April 2007, re: Paulson (We need to be sensitive of the profitability of these trades vs. profitability of abacus - we should prioritize the higher profit margin businesses with Paulson.).

 

123. Goldman Sachs internal email, dated May 2007, re: Post on Paulson and ABACUS 07-AC1 (100% Baa2 RMBS selected by ACA/Paulson).

 

124. Goldman Sachs internal email, dated May 2007, re: ACA We are done ! (Thank you for your tireless work and perseverance on this trade !! Great job.).

 

125. Goldman Sachs internal email, dated May 2007, re: Paulson update (...$91mm of 45-50 tranche risk that we would work on over the next few weeks - we are showing this trance to a few accounts @ 80bps.) .

 

126. Goldman Sachs internal email, dated June 2007, re: ABACUS 2007-AC1 Portfolio and OC for BSAM (We can offer approximately $91mm Class Junior SS Notes ....).

 

127. Goldman Sachs internal email, dated November 2007, re: ACA (...some of these trades have been outright short trades for us, and some of them have been crosses for Paulson.)

 

128. Goldman Sachs internal email, dated April 2008,( ...our infamous ABACUS 07-AC1 .... *** ...he may think these hedges are worth a lot more than they actually are ....).

[Guest LAW]

130. Goldman Sachs internal email, dated February 2007, re: Mortgage Risk - Credit residential (...you refer to losses stemming from residual positions in old deals. Could/should we have cleaned up these books before and are we are doing enough right now to sell off cats and dogs in other books throughout the division.).

 

132. Goldman Sachs internal email, dated July 2007, re: Mortgage Estimate (Much of the shorts are hedges for loans and some senior AAA CDOs (basis risk), but there is also a large net short that we are chipping away to cover - it will take time as liquidity is tough.).

 

133. Goldman Sachs internal email, dated July 2007,(If the shorts when up today, shouldn't the longs have dropped ....).

 

134. Goldman Sachs internal email, dated July 2007, ( Still have loads of index shorts vs. cash or

single name risk in mtg and credit which will bite us sometime.).

 

135. Goldman Sachs internal email, dated September 2007, re: Fortune: How Goldman Sachs defies

gravity (...the short position wasn't a bet. It was a hedge.).

 

139. Goldman Sachs internal email, dated June 2006, (...we can over-issue that specific tranche if it is perceived to be a good short.).

 

140. Goldman Sachs internal email, dated September 2006, re: MCC Posting - ABACUS 2006-14 (Like ABACUS 06-11 we expect to hedge by crossing the tranched shorts ... so we do not expect to retain any correlation risk.).

 

141. Goldman Sachs internal Memorandum to Mortgage Capital Committee, dated July 31, 2006, re: ABACUS 11 Structured Product Synthetic CDO (We expect to place $68.75 million of credit-linked notes from ABACUS 11 with Aladdin for inclusion in their high-grade Altius III and mezzanine-grade Fortius II CDO transactions, both of which are currently being arranged

by Goldman.).

142. Goldman Sachs internal email, dated December 2006, re: Opportunities/Challenges (Opportunities: ...ABACUS-rental strategies, according to which we "rent" our ABACUS platform to counterparties focused on putting on macro short in the sector.).

 

151. Goldman Sachs internal email, dated December 2006, re: Mezz Risk (We have been thinking collectively as a group about how to help move some of the risk.).

 

152. Goldman Sachs internal email, dated January 6, 2007, re: Post on Paulson (…could get comfortable with a sufficient number of obligations that Paulson is looking to buy protection on in ABACUS format ....).

[Guest LAW]

170.

a. Hudson High Grade Funding 2006-1, LTD Offering Circular dated October 30, 2006.

b. Hudson Mess 1 Trade Portfolio 11/16/2006.

c. Goldman Sachs internal email, dated October 2006, re: Hudson Mezz (..."AIB are too smart to buy this kind of junk" ....).

d. Goldman Sachs internal email, dated October 2006, re: Structured Product New Issue Pipeline (...guessing sales people view the syndicate 'axe" email we have used in the past as a way to distribute junk that nobody was dumb enough to take first time around.).

 

171. a. Standard & Poor's internal email, dated May 2006, re: Broadwick Funding (It was a known flaw not only in that particular ABACUS trade, but in pretty much all ABACUS trades ....).

b. Standard & Poor's internal email, dated April 2006, re: ABACUS 2006-12 - Writedowns immediately prior to Stated Maturity (don't even get me started on the language he cites...which is one of the reasons I said the counterparty criteria is totally messed up.).

c. Goldman Sachs internal email, dated March 2007, re: Structured Note Methodology (by the way, moodys should not know our price. Tell them its par and we will charge a higher fee if necessary.).

[Guest GOP 4 Life]

House Republican Leader John Boehner (R-OH) today praised the regulatory reform legislation – the Consumer Protection and Regulatory Enhancement Act – introduced by Financial Services Committee’s Ranking Republican Spencer Bachus (R-AL), his Committee Republican colleagues, and Judiciary Committee Ranking Republican Lamar Smith (R-TX):

 

“The common-sense plan introduced today will protect investors, consumers, and taxpayers at a time when they need it most. Americans are fed up with taxpayer-funded bailouts, and Republicans are committed to protecting middle-class families from the endless bailouts that have become a fixture in Washington. This Administration – with the help of Democrats who control Congress – continues to pile up mountains of debt on the backs of our children and grandchildren and taxpayers cannot afford to pick up the tab any longer. It’s time to get the government out of the bailout business and stop the reckless spending here in Washington, and this regulatory reform bill will help accomplish that goal.

 

"Our plan offers a stark contrast to the Democrats’ approach, which adds new layers of government bureaucracy and imposes new regulations that restrict consumers’ access to financial products and services. Under the Democrats’ plan government bureaucrats would decide what is a reasonable product, price, or service. Our plan rejects that approach and instead focuses on bolstering anti-fraud protection efforts, streamlining the hodge-podge of confusing federal agencies, and improving transparency and accountability so that consumers can make informed choices. I thank Rep. Bachus and his GOP colleagues for the work they put into crafting this comprehensive regulatory reform proposal.”

 

NOTE: Today House Financial Services Committee Republicans – led by Ranking Republican Spencer Bachus, Reps. Scott Garrett (R-NJ), Jeb Hensarling (R-TX), Tom Price (R-GA), Judy Biggert (R-IL), Shelley Moore Capito (R-WV), Randy Neugebauer (R-TX), and Judiciary Committee Ranking Republican Lamar Smith (R-TX) – introduced regulatory reform legislation to ensure that (1) the government stops rewarding failure and picking winners and losers; (2) taxpayers are never again asked to pick up the tab for bad bets on Wall Street while some creditors and counterparties of failed firms are made whole; and (3) market discipline is restored so that financial firms will no longer expect the government to rescue them from the consequences of imprudent business decisions.

[Guest Mary Vought]

U.S. Congressman Mike Pence, Chairman of the House Republican Conference, made the following statement today in support of the House Republican Financial Regulatory Reform plan:

 

"The American people are hurting and the last thing they want is more bailouts from Washington. They recognize that providing a hand-out to failing businesses really means that the federal government is burying generations under a mountain of debt and destroying the very foundation of free market capitalism that has allowed this great nation to prosper for generations.

 

"Let me be clear, Congress cannot continue to ask our nation's hard-working families, who have played by the rules, lived within their means, and paid their bills, to bailout the irresponsible decisions of others or the failed policies of Washington. Enough is enough.

 

"Today, House Republicans are standing with the American people who have said loud and clear: no more bailouts. The House Republican Regulatory Reform plan is a commonsense solution that puts taxpayers first, restores much needed market discipline and addresses the root of our financial troubles without forcing our children and grandchildren to foot the bill."

[Guest Maker's Mark]

The following is a letter from The Swaps & Derivatives Market Association (SDMA) to The Senate Committee on Agriculture, Nutrition, and Forestry and The Senate Committee on Banking, Housing, and Urban Affairs:

 

To: The Senate Committee on Agriculture, Nutrition, and Forestry

 

The Senate Committee on Banking, Housing, and Urban Affairs

 

The Swaps & Derivatives Market Association (SDMA) is a trade group comprised of more than 20 United States based Broker-Dealers and Futures Commission Merchants. Our members trade and/or clear credit, equity and commodity products, providing improved liquidity, transparency, and reduced transaction costs to the derivatives marketplace. Our trading and clearing activities are directly responsible for the reduction of systemic risk consistent with the objectives of your proposed legislation.

 

The SDMA supports the Senate Agricultural Committee's efforts to bring greater accessibility, accountability, and transparency to the centrally cleared OTC derivatives marketplace.

 

The SDMA believes that for central clearing to truly work, the Senate Agricultural Committee and the Senate Banking Committee Bills should mandate:

 

* Regulation of OTC derivative markets to enforce objective standards of capital adequacy, fair dealing, and free competition;

 

* Open and unfettered access to clearinghouses for all executing broker/dealers, sufficiently capitalized clearing brokers, and institutional market participants;

 

* Standardized credit default and interest rate swaps must be cleared;

 

* Expeditious introduction of portfolio margin by the SEC and CFTC to ensure the United States remains competitive with other financial centers, such as the United Kingdom.

 

Indeed, it is the responsibility of the regulators and legislators to proactively protect all OTC derivative market participants, large and small, from anti-competitive behavior and market manipulation, much like they have historically done in other markets.

 

To these ends, the bill that passed the Agriculture Committee on April 21st, 2010 is a positive first step. The SDMA would be pleased to discuss methods of bringing even greater transparency, accessibility, and fairness to the derivatives markets through this legislation or otherwise. Critical aspects of this reform include: elimination of the artificial restriction of market-making linkage to clearing, incorporation of stronger antitrust language, and prevention of self-certification to ensure the integrity of clearing house board composition and governance.

 

We look forward to working with the Senate Agricultural Committee and the Senate Banking Committee on these issues of national importance. We seek to ensure fair competition and improved stability of the United States financial system. Our goal is to increase the transparency, safety, and soundness of the financial derivatives marketplace, given its central importance to issuers and investors worldwide.

 

Sincerely,

 

 

Mike Hisler

 

 

SDMA Spokesperson

 

 

(212) 572-9041

 

Agency Trading Group, Inc.

 

BTIG, LLC

 

Chapdelaine Credit Partners

 

Cohen & Co.

 

CF Global Trading, LLC

 

CRT Capital Group, LLC

 

Hexagon Securities, LLC

 

IDX Capital, LLC

 

Imperial Capital, LLC

 

Miller Tabak Roberts Securities, LLC

 

Jefferies & Co.

 

Newedge USA, LLC

 

The PrinceRidge Group, LLC

 

The Seaport Group

 

StormHarbour Partners, LP

[Guest Senate Democrats]

Just a few hours before the Senate voted on a motion to proceed to floor debate on Wall Street reform, Banking Committee Chairman Chris Dodd set out to explain what's at stake with passing this legislation. "We are as vulnerable as we are today in the waning days of April 2010 as we were in the fall of 2008 when we saw what happened to our economy," said Dodd. "Hardly do we claim perfection in what we've written [for this bill] but we believe in sound ideas that deal with these very issues that caused the problems in the first place. What we need to do is to be able to debate those."

 

[Guest LAW]

Speech by SEC Commissioner:

Protecting Investors by Requiring that Advice-Givers Stay True to the Fiduciary Framework

by Commissioner Luis A. Aguilar

U.S. Securities and Exchange Commission

Investment Adviser Association Annual Conference

Chicago, Illinois

April 29, 2010

 

I would like to take you back in time to the passage of another piece of historic legislation, the Investment Advisers Act of 1940. The Advisers Act and its companion legislation, the Investment Company Act of 1940, resulted from a comprehensive congressionally-mandated study conducted by the SEC of investment companies, investment counsel, and investment advisory services. Ultimately, the report concluded that the activities of investment advisers and advisory services "patently present various problems which usually accompany the handling of large liquid funds of the public." The SEC's report stressed the need to improve the professionalism of the industry, both by eliminating tipsters and other scam artists and by emphasizing the importance of unbiased advice, which spokespersons for investment counsel saw as distinguishing their profession from investment bankers and brokers. The general objective "was to protect the public and investors against malpractices by persons paid for advising others about securities."3

 

The report stressed that a significant problem in the industry was the existence, either consciously or, more likely, unconsciously, of a prejudice by advisers in favor of their own financial interests. Reading through the volumes of the SEC report, the evidence is clear that whenever advice to a client resulted in a financial benefit to the advice-giver — over and above the fee —it was feared that the resulting advice might be tainted. Even more importantly, as cited by the Supreme Court, SEC staff rejected an early market discipline argument by recognizing that "a significant part of the problem was not the existence of a deliberate intent to obtain a financial advantage, but rather the existence subconsciously of a prejudice in favor of one's own financial interests." Consequently, the Advisers Act required advice-givers, as fiduciaries, to bear the burden of providing disinterested advice and being able to prove it.

 

As stated by the Supreme Court, "[t]he Investment Advisers Act of 1940 thus reflects a congressional recognition of the delicate fiduciary nature of an investment advisory relationship, as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser — consciously or unconsciously — to render advice which was not disinterested." Best of all, Congress and the Court placed the burden for providing disinterested advice and eliminating or disclosing conflicts squarely where it belonged, in the hands of the advice-giver. This places the obligation in the hands of those responsible for upholding their fiduciary duties rather than unfairly and unrealistically burdening investors to discern conflicts and incentives — an often impossible task.

Flash forward from the 1930s to the events of the last two years, and an array of examples will come to mind demonstrating the role that advice tainted by conflicts of interest played in harming investors and harming market integrity. Tainted advice led investors to invest billions of dollars in auction rate securities because brokers told them they were safe investments. Conflicts of interest at credit rating agencies contributed to AAA ratings on products that turned out to be worthless. Clearly, the concerns giving rise to the Advisers Act are even more relevant today. We need to restore the clear and strong rules that protect investors and, more than ever, we need to ensure that investment advice is disinterested.

 

Recently, in the context of an enforcement case, our own Director of the Division of Enforcement, Robert Khuzami, summed up the harm succinctly when he stated, "The product was new and complex but the deception and conflicts are old and simple." The events of the last two years have underscored an age old truth that financial products and technologies will continually change but the potential for deception and conflicts endure.

 

Lack of a Fiduciary Duty Leads to Real Investor Harm

 

An issue that illustrates this is the discussion around extending the fiduciary duty that underlies the investment adviser regulatory framework to broker-dealers who provide investment advice. This is the ultimate investor protection issue — because the harm to investors is real if broker-dealers giving advice are not held to the fiduciary standard and fail to put their client's interests before their own.

 

The fiduciary standard has served advisory clients well for many years and it should be the governing standard whenever investment advice is provided. If you are giving investment advice to an investor, regardless of the title on the business card, you should always be bound to do so in the best interests of the client. While the scope of service may vary between clients, the standards of loyalty and care in providing that service should not.

Currently broker-dealers are providing investment advice without any requirement that they serve as fiduciaries. In other words, broker-dealers are being permitted to end-run the Advisers Act. While brokers are required by current law to make certain disclosures about securities that are offered to investors, they are not required to make disclosures about certain of their own conflicts of interest. As a consequence, investors are susceptible to receiving tainted advice from broker-dealers and they will have no way of knowing that the advice was tainted by an undisclosed conflict.

 

Because broker-dealers are not fiduciaries, investors are not required to be informed of possible conflicts that may affect the advice they receive. For example, investors may not be told that the representative sitting across from them may receive undisclosed compensation from the investment option he or she just recommended. Since many broker-dealers aggressively market themselves as "financial advisers," investors have a difficult time distinguishing them from investment advisers. As a result of this confusion, they will fail to understand that the broker-dealer, unlike an investment adviser, is not required to place their interests first.

 

The danger is not simply that investors are unable to distinguish between broker-dealers and investment advisers; it is that both entities are providing investment advice to investors with dramatically different consequences. Although often marketed in the same way, the investment advice that investors receive from broker-dealers does not come with the same protections as advice received from investment advisers.

The Advisers Act has been designed to empower investors and provide them with the information that they need to evaluate conflicts and decide whether to enter into or continue an advisory relationship. Broker-dealers who are giving advice are not doing so within this investor-focused fiduciary framework. As the noted expert, Tamar Frankel stated,

 

That is the difference between suitability standards and fiduciary standards. The disclosure made under suitability standards is about what is being sold and not who sells it. That is why the time has come to change the law. The salesperson's temptation is too great when investors trust them, and disaster is too painful if the investors cease to trust all salespersons, and choose to avoid the financial markets altogether.

 

The fiduciary standard guards against the inherent bias that arises when the broker-dealer is focusing on selling a product, rather than focusing only on what is best for a client. Permitting broker-dealers to provide investment advice without requiring them to act as fiduciaries is to permit a practice that undercuts the core principles of the Advisers Acts and leaves investors vulnerable to the same abuses described in the 1930s.

Landscape of Legislative Proposals

 

As we look at the landscape of legislative proposals, I have to first reiterate what I said here last year. There is only one true fiduciary standard, and it means an affirmative obligation to act in the best interests of the client and to put the client's interests above one's own.

 

Accordingly, it was heartening last year to see that the Obama Administration in its White Paper on Financial Regulatory Reform explicitly state that the standard of care for broker-dealers who provide investment advice should be raised to the fiduciary standard applied to investment advisers. This was followed by provisions in both the Wall Street Reform and Consumer Protection Act (the "House Bill") and the initial draft of the Restoring American Financial Stability Act (the "Senate Bill") that would have extended to broker-dealers the traditional fiduciary standard applicable to investment advisers.

Of the two legislative proposals, the initial draft of the Senate Bill was significantly stronger. It would simply have eliminated the distinction between broker-dealers and investment advisers when providing investment advice. By comparison, the House Bill would instead require that the Commission promulgate rules to subject broker-dealers providing "personalized investment advice about securities to a retail customer" to the standard of conduct in the Investment Advisers Act. In other words, the House Bill would not apply the same standard to all brokers who provide advice — but rather only to those providing personalized services to retail customers. This language limits the universal application of the fiduciary standard and excludes many investors from its protection.

 

The Senate Bill, however, has abandoned its strong position in the face of determined lobbying by the insurance and brokerage industries. The revised version that was voted out of the Senate Banking Committee on March 22nd has eliminated the provision applying the fiduciary standard to brokers who provide investment advice. It would, instead, require a one-year study by the SEC concerning the effectiveness of existing standards for "providing personalized investment advice and recommendations about securities to retail customers."

 

I continue to have concerns about this retreat from requiring a fiduciary standard for all who provide investment advice. First, I see no need to study the effectiveness of existing obligations for investment advisers. We already have a strong, workable standard that has been in use successfully for decades, and I would not support any attempt to weaken it. Second, as with the House Bill, I question why the protection of the fiduciary standard should be limited to "retail" customers. It is readily apparent from recent Commission enforcement cases — such as the cases involving auction rate securities — that all investors, including institutional investors, need the protection of the fiduciary standard. Third, I question why the study, as well as the reach of the House Bill, should be limited to "personalized services." This qualification would narrow the range of clients that would be protected by the fiduciary standard, and I fear that it may become a loophole that would make it easy to avoid putting clients first.

 

Finally, I don't believe that we need an additional study to conclude that protection of investors requires that broker-dealers providing investment advice be subject to fiduciary duties. I think that question has long ago been asked and answered. We need to remain vigilant to make sure that investors who receive advice do so from intermediaries held to the high standards of care and loyalty embodied in the existing fiduciary standard under the Investment Advisers Act.

 

SEC is the Regulator of the Investment Adviser Industry

 

As regulatory reform moves forward and the Commission evaluates its priorities, we must recognize that strong laws and rules are only one component of an effective regulatory framework. These laws and rules must also be accompanied by robust examination and enforcement oversight. That brings me to the SEC's Office of Compliance Inspections and Examinations (OCIE).

 

I have previously spoken about the need to reinvigorate the SEC's examination and inspections program — by increasing our examination resources, adding to the skills and experience of our staff, and removing handcuffs imposed by ill-advised internal SEC policies. I've also discussed the need for legislative action to clarify and expand the SEC's examination authority to include, among other things, entities that should be registered under the securities laws, entities that have recently withdrawn from registration, and relevant records of certain associated persons of registered entities.

As I also mentioned last year, there is no doubt that OCIE's examination resources need to be strengthened. For example, while the number of registered investment advisers has increased over the past five years by 33%, from 8,623 to 11,500, the staff dedicated to examining advisers and mutual funds has decreased over the same period by 13%, from 489 to 425. As a result, we can examine only a fraction of the advisers and fund complexes each year.

 

In order to address this problem, as well as others, the SEC must be adequately resourced. As I have been consistently advocating, the single most transformational act that Congress could undertake is to allow the SEC to be self-funded. Unlike almost every other financial regulator, the SEC remains without a consistent funding stream. Self-funding would enable the SEC to set multi-year budgets and respond promptly to our dynamic capital markets, while also maintaining appropriate staffing. Self-funding would allow us to have the resources to keep up with the growth in the industry.

 

Accordingly, I am pleased to report that the most recent version of the Senate Bill would make self-funding a reality. Of course, the legislative process is on-going and the results are far from predictable. I know that the Investment Adviser Association has been a strong proponent of self-funding for the SEC every time this issue has been seriously considered. I thank you for being willing to speak frankly on the issue and thank you in advance for the work to come.

 

Beyond the resource issue, there is another structural change that the legislation would trigger. There is a provision in the Senate Bill that would, in essence, disband OCIE as it currently exists. The Senate Bill provides that the exam staff would be redeployed from the stand alone Inspections and Examinations Unit to the Divisions of Trading and Markets and Investment Management.

 

The proposed redeployment takes us back in time. In 1995, Chairman Arthur Levitt created OCIE for the express purpose of consolidating examination resources to better utilize them to protect investors. One of the criticisms of OCIE, as well as of the entire SEC, is that it is too fragmented and does not utilize expertise across the agency. I am concerned that creating specialized groups of examiners at a time when the industry has numerous dual registrants is to ignore the reality of those we regulate. Moreover, since 1995, the services provided by broker-dealers and by investment advisers have increasingly come to resemble each other, undercutting the argument that separate examination staff is appropriate.

 

While I am sympathetic to the need to integrate our examination function more deeply into the workings of our rule-making and programmatic divisions, I fear that this redeployment may have the opposite effect. The resulting fragmented oversight could make it harder for the SEC staff to detect and prevent wrongdoing.

 

Furthermore, and of the greatest concern to me, by legislatively mandating separate and fragmented inspection and examination programs, the SEC would lose the flexibility to make future determinations of how best to oversee the industry. In a dynamic industry that is continually evolving, and increasingly consolidating, it is necessary for the SEC to be in a position to determine the most effective means to fulfill its responsibilities. We should not have our hands tied as to what may be the best way to provide effective oversight, either now or in the future. I hope that the members of the Senate rethink this provision.

Rectifying Regulatory Inaction

 

Even as the legislative process winds its way forward, the Commission continues to be active on a scale few can remember. Before I discuss three initiatives that directly impact the investment advisers' fiduciary framework, I would like to talk about the cost of regulatory inaction. Much is written about the fear of too much regulation. However, since I became a Commissioner, I have been struck by the opposite, the cost of regulatory inaction. Thus, in the mix of priorities, I believe it is important for the Commission to take on initiatives to rectify investor harm resulting from regulatory inaction. The events of the last several years have demonstrated the cost of regulatory inaction. I would like to highlight two initiatives that would significantly improve the adviser fiduciary framework — and that have been languishing for decades.

 

For example, in 1999, the Commission proposed pay-to-play rules to prevent the exact conduct that we have been confronting in states across this country. These rules were not adopted and, in the decade since, significant assets have been inappropriately allocated, and public confidence in investment advisers and public pension funds across this country has been shaken. If the rule had been adopted in 1999, would we be facing pay-to-play scandals of this magnitude? It's doubtful.

 

Similarly, amendments to the core disclosure document of the adviser's regulatory framework, the Form ADV Part II have languished. Initially proposed in 2000 but not adopted, the Commission re-proposed these amendments in 2008 but, again, failed to adopt them. This is a core disclosure document that is antiquated and the Commission should prioritize the adoption of these amendments.

 

Before I discuss these proposals in greater detail, I want to touch on a custody initiative that is still to come.

 

The Need to Strengthen Custodial Practices to Protect Investors and Their Assets

 

Last December, the Commission adopted amendments to various rules to strengthen safeguards to protect clients' assets controlled by investment advisers. This action was intended to protect against the misappropriation of client funds by advisers who serve as custodians and hold on to, or have control over, their client's assets. These advisers are now subject to annual examinations by an independent auditor: a "surprise exam" to verify client assets, and a review of internal custody controls. I know there have been implementation issues with this rule and I know that the industry has been working closely with our staff to insure compliance.

 

I would like to highlight one issue related to the recent revision to the investment adviser custody rule. The Commission's adopting release made it clear that this rule had the potential to disproportionately impact small advisers who have the authority to obtain possession of client funds, such as by serving as trustees, even thought the client's assets are held by an independent qualified custodian. The release also indicated that the Commission has directed the staff to evaluate the impact of the rule on advisers and their clients. In particular, the SEC staff has been directed to conduct a review following the first round of surprise examinations and provide the Commission with the results of the review, along with any recommendations. I have noticed the recent press discussing potentially significant auditing costs that advisers serving as trustees may have to pay for their custodial clients. In order that we may be fully informed as to the impact of this aspect of the rule, I encourage you to collect information and to relay any pertinent information to the staff.

 

While I supported the adoption of the amendments to the custody rule, I stated at the time that it was not enough. As this audience knows well, the amendments were prompted by the revelation of the Madoff Ponzi scheme. I felt that our action did not go far enough because it did not address Madoff's actions as a broker-dealer. It's important to recognize that the Madoff Ponzi scheme lasted for decades — potentially starting in the 1980s — and for much of that time Madoff was registered only as a broker-dealer. The victims lost money from discretionary, commission-only brokerage accounts. It was only in 2006 that Madoff registered as an investment adviser.

 

Thus, even if the rule had been in effect, it would not have applied to the Madoff broker-dealer and the rule would not have prevented much of the harm that Madoff did. Moreover, you need to remember that because investment advisers are required to maintain their clients' assets with qualified custodians, such as banks and broker-dealers, very few advisers actually hold physical custody of client assets.

 

Accordingly, tightening the rules applicable to investment advisers without assessing and strengthening the underlying broker-dealer rules is not enough. To that end, I have urged the SEC staff to move quickly toward developing proposals to strengthen the broker-dealer framework. I hope to see the staff's proposal in the near future.

Reducing the Temptation of Advisers to Misuse Political Contributions

 

As I alluded to earlier, the Commission has also re-proposed a rule to limit the ability of investment advisers to make political contributions in order to be chosen to manage public pension fund money. In other words, this rule is intended to reform the pay-to-play system that has been documented far too often.

 

The pension fund business is substantial. State and municipal pension plans hold over $2.3 trillion of assets and represent one-third of all U.S. pension assets. These plans are typically administered and managed by elected officials who also have the responsibility of selecting the investment advisers who oversee the plans. Obviously, these plans pay significant advisory fees to investment advisers, making the management of these plans highly desirable business. Advisers compete fiercely to win this business — and, for the most part, compete fairly based on their qualifications.

 

The concern behind the proposal is that some advisers and elected officials are engaging in pay-to play conduct — where advisers make political contributions to elected public officials who oversee public pensions in order to be chosen to manage some of the pension business. This type of conduct distorts the marketplace and is incredibly hard to police. The proposed rule is the Commission's attempt to ensure that advisers compete for pension plan business on a level playing field and that they fulfill their fiduciary obligations and put the interests of the plan beneficiaries above all others.

 

To crystallize — if an adviser wins business because it has "paid" in order to "play," there are serious doubts as to whether the most qualified adviser was selected for the job. After all, in such a case, the adviser selection process would not appear to be based on merit and qualification. If the best person was not selected for the job, the plan could suffer inferior management that may lead to greater losses. The plan may also be paying higher fees because the adviser may be trying to recoup its political contributions or because the contract negotiations were not exactly arms-length.

 

It is important to note that the proposed rule, while regulating investment advisers, would not reach the conduct of the elected officials who serve as public pension plan trustees. These individuals engage in serious conflicts of interest when they accept political contributions from those who do business with the plan. I applaud the state and local authorities who have taken steps to prohibit pay-to-play activity and I encourage more to do the same.

Revisions to Form ADV, Part II

 

Lastly, let me say a word about Form ADV. As those in this room know, Form ADV is the core disclosure document for every registered adviser. In particular, Part II of Form ADV is the disclosure document provided to clients and includes key information including the services provided, the applicable fees, conflicts of interests, and other specified information. Part II is the primary document by which investors receive the information they need to decide whether to hire an adviser. Unfortunately, the current form is sadly antiquated and a modern day adviser's services may not correspond well to the limited number of options on the form. As a result, the resulting disclosure may not describe the adviser's business or conflicts in a way that investors can readily understand.

 

The need to update Part II has been clear for over a decade. In April 2000, the Commission proposed comprehensive amendments to Part I and II of Form ADV; but although the Commission adopted the amendments with respect to Part I, the amendments to Part II did not see the light of day. Then, in March of 2008, the Commission re-proposed various amendments with the aim of providing clients and prospective clients with plain English disclosure of the business practices, conflicts of interest, and background of investment advisers and their advisory personnel. It is expected that the Commission will soon revisit Form ADV.

 

While there are many aspects of the amendments that merit discussion, I want to focus on one — the brochure supplement. Currently, investors receive information about executives of the advisory firm but little to none about the educational background or disciplinary history of the advisory personnel sitting across the table. The Form ADV proposals, in 2000 and 2008, proposed a brochure supplement to provide investors much needed information in real time. The supplement would contain information as to the qualifications of the advisory personnel who will be providing the investor with the personalized investment advice.

I believe that clients would benefit greatly from the information to be conveyed through the proposed supplement — particularly where the advisory personnel has a disciplinary history. I know this particular proposal generated robust comment and I look forward to the staff's recommendations.

Conclusion

 

The regulatory landscape is changing, and its future state is uncertain. As investment advisers, you have a critical role to play in any regulatory improvements for advisers. Investors place their trust in you to act as their fiduciaries in managing their investments, but they also need you to bring your experience and expertise to the discussion of strengthening industry regulation.

[Guest HUMAN]

http://www.csmonitor.com/Commentary/the-monitors-view/2010/0429/Financial-reform-without-Fannie-and-Freddie

 

Financial reform without Fannie and Freddie?

 

The Senate debate on a financial reform bill is not focused on the two mortgage giants whose risky loans contributed to the frenzy and near-collapse of Wall Street. Why put off a needed debate on the government's future role in pushing cheap home loans?

 

The Senate began debate Thursday on an overhaul of the financial-services industry. Conspicuously left out of the main bill are any big reforms of the housing finance system – whose roguish, risk-taking behavior was at the root of Wall Street’s near-meltdown.

 

In fact, the Obama administration wants to put off such reforms until home prices are stable, possibly next year. Another reason is that taxpayers are still bailing out the two biggest players in home finance, Fannie Mae and Freddie Mac, which repackage mortgages and resell them as securities.

The two giants were put into government conservatorship in 2008. Since then they have been the largest recipients of taxpayer dollars in a string of bailouts. They’ve eaten up close to $400 billion in rescue funds. And they still have taxpayers responsible for some $6-8 trillion (yes, trillion) in obligations. Five months ago, the Treasury Department had to announce that federal support for the two government-sponsored enterprises (or GSEs) would be open-ended for a long time.

 

Treasury Secretary Timothy Geithner says past problems with Fannie and Freddie were “symptomatic” of the regulatory failure of the financial industry. The two bought up subprime mortgages “without regard to the risk they posed to the system,” he told Congress last month. And they didn’t have enough capital cushion and were “inadequate” in their risk management.

Yet he and President Obama do not want reform of Fannie and Freddie in this Senate debate.

 

How can Wall Street itself be reformed without a Fannie-Freddie overhaul? The US mortgage market remains the second largest market for securities in global finance. The two GSEs represent nearly half of the residential mortgage market.

 

And even as Mr. Obama promises no repeat of the big bailouts of 2008-09, he’s still putting money into these big players.

 

As a presidential candidate, Obama was not in favor of keeping Fannie and Freddie in their role as market stabilizers for home loans with government backing. In fact, the Treasury Department has already outlined a different model for the two GSEs and has asked the public for ideas. But specific reforms are still secret.

 

Mr. Geithner did offer this in March: “After reform, the GSEs will not exist in the same form as they did in the past. Private gains will no longer be subsidized by public losses, capital and underwriting standards will be appropriate, consumer protection will be strengthened, and excessive risk taking will be restrained.”

 

The excuse of waiting on reform until home prices stabilize may not be the real reason for delay. Reform can happen even as the GSEs continue their mortgage work. The likely reason is that big political questions remain about how much government should still push the American dream of home ownership.

 

Will a revised Fannie and Freddie again be under pressure from Congress to go easy in providing credit to less-than-worthy home buyers? And will the two entities again recycle their profits into the campaign coffers of lawmakers who set policies for them?

 

Between 2000 and 2007, the portion of substandard home loans in the mortgage portfolios of the two GSEs went from near zero to 23 percent. This risky behavior to help the poor and middle class buy a home may have made sense at the time, as home prices had not fallen in a sustained way since the 1930s. But the near-collapse of Fannie and Freddie as home prices began to fall in 2006-2007 only revealed in hindsight that the two GSEs lie at the center of the US financial system.

 

If the two come up for reform soon, the guiding principle should be just what Geithner advises: “The mortgage finance system should not contribute to systemic risk or overly increase interconnectedness from the failure of any one institution.”

[Guest Ron]

Manufacturing tanked. The Dot.com tanked. So the housing market is what is left. The Government is afraid to touch it.

[Guest Greenzen]

Regulatory agencies begin to identify with the interests of the regulated rather than the public they are charged to protect. - CATO

[Guest AlwaysRed]

I think one of the people we need to thank for the this mess is President Clinton. Do you people remember when he decided to create SEC rules that force Lending companies to give out Home Loans to people who really could not afford it. Then when the economy started slipping, those low variable rates turned into a nightmare and this the housing crisis ensued. When Bush took office in 2000, he tried to get those rules removed b/c he knew there would be a problem and the Democratic congress told him to F off. You can thank the Democratic Congress for spending your money, raising your taxes and reducing services. Fiscal responsibility is not part of the democrats vocabulary.

[Guest greenzen]

I think everyone is now aware that the Federal Reserve, The Bank Cartel, Financial Brokers, Hedge Fund managers, Fannie Mae, and Freddie Mac were the problems to this financial meltdown. The question is what is Congress going to do about it.

[Guest anniegetyourgun]

I think it is surprising that we fail to mention that it was Congress that repealed the Glass-Steagall Act which allowed Commercial Banks to enter the Investment Banking industry and take risks that should have been allowed. Why do you think the people who saw the Crash of 1929 first hand passed such a law?

[Guest LAW]

If you do a little research you will learn how the Bush family made their money and how some things never change.

 

In 1931, William Averell Harriman hired his son-in-law, Prescott Bush as Vice President of W.A. Harriman & Co. Walker then retired to his own G.H. Walker & Co.

 

The bank had a huge windfall in 1933 with the passage of the Banking Act of 1933, a.k.a. the Second Glass-Steagall Act. Commercial banks were prohibited from the investment banking business giving private firms like Brown Brothers Harriman monopoly control.

 

On Oct. 20, 1942, the U.S. government ordered the seizure of Nazi German banking operations in New York City which were being conducted by Prescott Bush. Under the Trading with the Enemy Act, the government took over the Union Banking Corporation, in which Prescott Bush was a director. The U.S. Alien Property Custodian seized Union Banking Corp.'s stock shares, all of which were owned by Prescott Bush, E. Roland "Bunny'' Harriman, three Nazi executives, and two other associates. The order was signed by Leo T. Crowley, Alien Property Custodian, executed October 20, 1942; F.R. Doc. 42-11568; Filed, November 6, 1942, 11:31 A.M.; 7 Fed. Reg. 9097 (Nov. 7, 1942).

[Guest Bob Chapman]

We were told that we should get rid of the Glass-Steagall Act because it was outdated and it interfered with the proper function of modern financial markets, but the real reasons for the resulting Gramm, Leach, Bliley Act (signed by Slick Willy near the end of his term as a parting gift to the US public), which repealed the Glass-Steagall Act, was to allow Wall Street fraudsters to pawn off the toxic waste securitizations created by their investment banking subsidiaries on their own commercial banking clients, to allow acts of moral hazard and conflicts of interest to be legally perpetrated, to turn our financial markets into a gambling casino and to allow non-insurance companies with completely inadequate reserves to underwrite against potential bond principal and interest losses. Auction rate bond investors were told that their funds were being invested in AAA paper as good as cash, but they were really chasing a higher yield made possible through a market created by the fraudsters to pawn off their municipal toxic waste, and now that municipalities are in trouble due to waning tax revenues, the fraudsters don't want to make a market anymore and have left their clients holding the bag with unmarketable, junk securities. We were told that we needed the Federal Reserve System to smooth out the business cycle and to stabilize inflation, and all we have had for almost a century is a boom-bust economy and out-of-control inflation time and time again so that insiders can line their pockets with the mega-profits that only wild economic volatility can produce for insider traders who are told exactly where and when to invest, and so the middle class can be stealth-taxed into oblivion to pay for profligate Congressional spending on Illuminist projects without raising income taxes to absurd levels (yes, even more absurd than we have now) and to make way for a world government in the wake of the destruction of the US economy and middle class. We were even told that because of all the financial turmoil we are now experiencing, that the Fed should be given complete regulatory control over the entire financial community, and not just over commercial banks within the Federal Reserve System. And never mind that the Federal Reserve is the main culprit behind all this financial turmoil.

[Guest Baudou]

Economists Robert Ekelund and Mark Thornton have also stated that the Gramm-Leach-Bliley Act (GLBA), also known as the Financial Services Modernization Act of 1999 as contributing to the crisis. They state that while "in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance" the Financial Services Modernization Act would have made "perfect sense" as a legitimate act of deregulation, but under the present fiat monetary system it "amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly."

 

Nobel Prize-winning economist Paul Krugman has called Senator Phil Gramm "the father of the financial crisis" due to his sponsorship of the Act. Nobel Prize-winning economist Joseph Stiglitz has also argued that the Act helped to create the crisis.

[Guest Enron Ex]

I have not heard to much mention of Phil Gramm since he traded a Texas Senate seat for investment banking. I wonder why didn't he ask his employer, UBS, to decline the billions of taxpayer dollars it received that were laundered through the AIG bailout. UBS got in trouble for helping the wealthy evade US taxes. Our government is harvesting many names of many UBS clients with offshore accounts of U.S. politicians hiding their money in Swiss bank accounts.

 

UBS Investment Bank Enters into Agreement with AIG to Acquire the Commodity Index Business of AIG Financial Products Corp

 

Zurich / New York, January 19, 2009

 

The Equities business of UBS Investment Bank announced today that it has entered into a binding agreement to purchase the commodity index business of AIG Financial Products Corp, including AIG’s rights to the DJ-AIG Commodity Index. This commodity index business is comprised of a product platform of commodity index swaps and funded notes based on the benchmark Dow Jones-AIG Commodity Index (DJ-AIGCI).

 

The purchase price for the transaction is $15 million, payable upon closing, and additional payments of up to $135 million over the following 18 months based upon future earnings of the purchased business. The closing is subject to a number of regulatory and other conditions. No assurances can be given that any such conditions will be satisfied.

The transaction is expected to close by May 2009.

 

About UBS

UBS is one of the world’s leading financial firms, serving a discerning international client base. UBS is a leading global wealth manager, a leading global investment banking and securities firm, and one of the largest global asset managers. In Switzerland, UBS is the market leader in retail and commercial banking.

 

UBS is present in all major financial centers worldwide. It has offices in over 50 countries, with about 37% of its employees working in the Americas, 34% in Switzerland, 16% in the rest of Europe and 13% in Asia Pacific. UBS employs more than 75,000 people around the world. Its shares are listed on the SIX Swiss Exchange, the New York Stock Exchange (NYSE) and the Tokyo Stock Exchange (TSE).

 

October 7, 2002

Senator Phil Gramm to join UBS Warburg

 

UBS Warburg today announced that Texas Senator Phil Gramm will join the firm as vice chairman. In this role, he will advise clients on corporate finance issues and strategy. Senator Gramm plans to join the firm at the end of his term. In his new role, he will work closely with Vice Chairmen Lord Brittan and Ken Costa, who are based in London.

 

Senator Gramm is retiring after serving 24 years in Congress, including the last 18 years as Senator from Texas.

 

Senator Gramm’s experience gained from more than 35 years in academia and government make him uniquely suited to assist our clients to meet the challenges presented by today’s business environment,” said John P. Costas, chairman and chief executive officer of UBS Warburg.

 

„I am delighted to enter the next phase of my career as an investment banker at UBS Warburg,” said Senator Gramm. „Having spent my professional life working on finance related issues, I look forward to bringing that experience and knowledge to bear on behalf of UBS Warburg clients worldwide.”

 

UBS Warburg is a business group of UBS AG (NYSE: UBS), one of the largest financial services firms in the world with more than 70,000 employees in more than 40 countries. UBS Warburg is a leader in equities, corporate finance, M&A advisory and financing, financial structuring, fixed income issuance and trading, foreign exchange, derivatives and risk management. UBS Warburg is one of four business groups of UBS AG along with UBS PaineWebber, UBS Global Asset Management and UBS Wealth Management & Business Banking.

[Guest HUMAN]

Law for all your posts this still remains the truth of which you are turning a blind eye to.

 

http://www.csmonitor...nie-and-Freddie

 

 

The writing is still on the wall, and even I don't have that type of hate in me.

 

If this "BILL" is to have ANY teeth to it? Then lets all put the blame GAME away and concentrate

on what's real.

[Guest Enron Ex]

I think you both are turning a blind to this issue. Crooks have political muscle in the country.

 

Case Example:

 

UBS Board member, Phil Gramm, was Senator McCain's chief campaign advisor. UBS CEO, Robert Wolf, was President Obama's chief fundraiser.

 

 

**************************

 

The Securities Law Firm of Klayman & Toskes Files Arbitration Claim Against UBS Seeking Recovery of $400,000 for Losses Sustained in Lehman Brothers 100% Principal Protection Notes and From Over-Conce

 

Securities Law Firm of Klayman & Toskes, P.A. ("K&T") (http://www.nasd-law.com) announced today that it filed a securities arbitration claim against UBS Financial Services (NYSE:UBS), Case No. 09-06092, seeking recovery of $400,000 for losses sustained in Lehman Brothers 100% Principal Protection Notes ("Lehman Notes") and from over-concentration in preferred financial stock. The claim was filed with FINRA Dispute Resolution.

 

The Claimant's UBS broker recommended that he invest $200,000 in the Lehman Notes. With the recommendation, the UBS broker advised the Claimant that his investment in the Lehman Notes was absolutely safe, had "no risk" and that at a minimum, he would receive 100% of his investment in the Lehman Notes once they reached maturity. Unfortunately, the UBS broker failed to inform the Claimant of the risks associated with the Lehman Notes, including the credit risk of the borrower, Lehman Brothers. Contrary to UBS' representations regarding the safety of the Lehman Notes, the Notes are now worthless. Had the Claimant been aware of the risks associated with the Lehman Notes, he would not have placed his savings in the Notes.

 

In addition to the recommendation to invest in the Lehman Notes, the UBS broker advised the Claimant to invest a significant percentage of his account in several preferred financial stocks, including those of Bank of America (NYSE:BAC), Allianz (NYSE:AZ), HSBC (NYSE:HBC), JPMorgan Chase (NYSE:JPM), and Merrill Lynch (NYSE:MER). The UBS broker told the Claimant that preferred stocks were low risk and would pay him a steady dividend. This allocation, however, exposed a significant portion of the Claimant's account to the financial sector. When the financial sector declined in 2008, the Claimant sustained significant damage to his portfolio.

 

While a class action lawsuit has been filed relating to the Lehman Notes, K&T reminds investors of the benefits of filing an individual arbitration claim, as opposed to participating in a class action lawsuit. By participating in a class action lawsuit, an investor will most likely recover only pennies on the dollar. However, if one has experienced significant investment losses, it may be more beneficial for them to file an individual securities arbitration claim. In 2003, Klayman & Toskes conducted a detailed study of securities arbitration versus class action. The study concluded that investors who file a securities arbitration claim traditionally obtain an overall higher rate of recovery as opposed to participating in a class action lawsuit. To view the full results of the comparison, please visit our web-site: http://www.nasd-law.com/documents/classvr.pdf

 

Retail and institutional investors who have sustained investment losses can contact K&T to explore their legal rights and options. The attorneys at K&T are dedicated to pursuing claims on behalf of investors who have suffered investment losses. K&T, an experienced, qualified and nationally recognized securities litigation law firm, practices exclusively in the field of securities arbitration and litigation. It continues its representation of investors throughout the world in securities arbitration and litigation matters against major Wall Street brokerage firms.

 

***************************

On a more positive note, the first issue of new privately issued mortgage-backed securities not backed by Fannie or Freddie in two years happened last week. An affiliate of the real estate investment trust Redwood Trust (NYSE: RWT), which specializes in jumbo mortgage loans, issued $222.4 million in bonds. Underlying the securities were 255 mortgages written by Citigroup (NYSE: C), with a face value of $237.8 million. According to Bloomberg, the properties involved had a loan-to-value ratio of around 60%, meaning that roughly $400 million in real estate backs the mortgages.

[Guest HUMAN]

The "Bill" has to include Fannie, and Freddie.

 

http://www.csmonitor...nie-and-Freddie

[Luke_Wilbur]

Amen. Fannie Mae, Freddie Mac and all public and private pension plans, cities, school districts and government- sponsored enterprises, etc... should be removed from the negotiated derivatives market.

 

Too many people get screwed in the deal. I hope you use all your political muscle Human to do this. Also, lets take a peek at the Fed. I also want the names of all the politicians who where evading taxes in offshore accounts. Those bastards should get a real hard boot out of office.

 

There are alot of snake oil salesmen that will not be getting too much sleep over this.

[Guest LAW]

Senator Gregg's Floor Statement on Financial Regulatory Reform and Derivatives

 

Mr. Gregg: Mr. President, I wanted to rise to speak on this bill also. It's a complex piece of legislation, which is difficult to debate in a sense that is understandable because there are so many technical aspects to the legislation. But let's start with what I believe our purposes should be.

 

Our purpose should be, one, to do as much as we can to build a regulatory regime that will reduce the potential for another event, the type of which we had at the end of 2008. There was a massive breakdown in the financial system of this country as a result of the huge systemic risks built into the system, which were not properly regulated, certainly not by either the financial institutions or Congress. Congress maintains a fairly significant responsibility for the meltdown that occurred at the end of 2008 – for the policies that we were running in the area of housing. That should be our first goal, trying to reduce systemic risk as much as possible in the system by putting in place policies which will accomplish that.

The second goal, however, should be that we maintain what is a unique and rare strength of America, which is the capacity that we have as a country to create capital and credit in a very aggressive way, so that entrepreneurs who are willing to go out and take risks have access to capital and credit, which creates jobs and the dynamics of our economy. And we shouldn't put in place a regulatory regime that overly reacts and, as a result, significantly dampens our capacity to have the most vibrant capital and credit markets in the world, while still having a safe and sound capital and credit markets.

 

Now, the bill that the Senator from Connecticut is bringing forward, I presume, is going to have a lot of different sections in it. I just want to focus on one, because it's become the point of significant attention and that's the derivatives section.

 

Derivatives are extraordinarily complex instruments and there are a lot of different variations of them. They're basically insurance policies on an underlying product that is being used somewhere in the economy. And their notional value is staggering, $600 trillion in value is out there in derivatives, which is a number that nobody can comprehend, but you can understand that it's a pretty big issue. Notional value means that if everything were to go wrong at the same time, you'd have $600 trillion of insurance sitting out there that would have to be paid off. That's not obviously ever going to happen, but the fact is it shows the size of this market and what its implications are.

 

There are all sorts of different elements in this market; it's not one monolithic market. It’s not even a hundred, it's thousands, tens of thousands of different things that have derivatives written against them, although they divide into pretty understandable categories.

 

Within the bill that came out of the Agriculture Committee, there was, for lack of a better word, an antipathy expressed towards the entities which presently manage the derivatives markets in this country, which are essentially the large financial houses. There was an equal antipathy expressed relative to the entities that use these derivatives, including manufacturing companies in this country, people who are dealing with financial debt instruments in this country, people who are dealing with the housing markets in this country. It was almost as if somebody sat back and said, “we really dislike these folks and we're going to put in place a regime that gratuitously penalizes them for the business that they do because we just don't like it. It's too big, and it's too complicated.” I think the people who wrote that legislation felt derivatives weren’t understandable and, therefore, they decided to put forward proposals that would fundamentally undermine the capacity to trade derivatives in this country.

Is that bad? Yes, it's very bad, because when derivatives are used for their intended purpose, they make commerce work in our nation. They make it possible for people to borrow money, for companies to sell overseas, making it possible for people to put a product into the stream of commerce and presume that when they enter into an agreement on that product, the price will be not affected by extraneous events such as fluctuations in the cost of currency or material. So it's really critical that we get the derivatives language right.

 

Now, there needs to be a significant and new look at the regulatory regime of derivatives. And the essence of the exercise should be transparency, maintaining adequate capital, margins, and liquidity for the counterparties. That should be where we focus our energy. Trying to make sure that the different derivatives brought to the market are as transparent as possible and also have behind them the support they need in the form of collateral, capital, and margin to be paid off if something goes wrong.

 

This proposal, however, as it came out of the Agriculture Committee, doesn't try to accomplish that. Rather, it tries to eviscerate the use of derivatives as products amongst a large segment of our economy. It sets up something called Section 106, where it essentially says that the people who are dealing derivatives today, which are for the most part large financial houses, must spin those products off from their financial houses. Now, that sounds, in concept, like a reasonable idea, especially if you were in Argentina in 1950 and working for the Peron government. But as a very practical matter, it's a concept which will do fundamental harm to the vitality of our economy. Why? Because you won't have a lot of derivative products in this country that will be able to pass the test of being spun off.

 

You don't have to listen to me to believe this. Let me just quote from a message that was sent to us by the Federal Reserve, which is a reasonably fair arbiter in this exercise. They really don't have a dog in this fight other than the financial stability of our country. Section 106 -- this is the Fed talking, not me -- "would impair financial stability and strong prudential regulation of derivatives; would have serious consequences for the competitiveness of United States financial institutions; and would be highly disruptive and costly, both for banks and their customers." That's about as accurate and succinct a statement as to what the effect of this section would be as I could have said, but I didn't say it. Nobody would probably believe me. The Fed said it, the fair arbiter said it.

 

Now, why did they say that? Well, it's pretty obvious, if you know anything about the way these products work. Essentially if you spin off these products, you're going to have to create entities out there to replicate the entities that they were spun off from. So if a large financial institution is now dealing derivatives and you spin the derivatives or the swap desk off from that financial entity, that spun-off event is going to have to replicate the capital structure of the financial institution that was basically underpinning the derivatives desk. And so that capital structure is estimated to be somewhere in the vicinity of a quarter of a trillion dollars to half a trillion dollars of capital will have to be created.

 

Well, what's the effect of that? When you start putting capital like that into the system, that capital has to come from somewhere, assuming it comes at all. And where it comes from, quite honestly, is the credit worthiness of other activity. It's not new capital. It's taking capital and recreating an event, a free standing entity here, which capital isn't around. It also will mean that there will be a contraction -- and this is an estimate not of the Fed but of the group of entities that actually do this business and, therefore, it can be called suspect – but I think it's in the ballpark. It will take a couple hundred billion dollars. It will also cause a contraction of about $700 billion in credit in this country, to say nothing of the fact that if you're looking for a derivatives contract and you can't go to the financial houses that usually do it in the United States and if you're a commercial entity or a hedging group, you're going to have to go overseas and do it because they aren't going to have these types of restrictions. And you're going to be able to buy that contract in Singapore. So a large number of entities and businesses will move offshore almost immediately upon the passage of this bill should this section be kept in.

 

Is this necessary to make the derivatives market work right in this country? Absolutely not. This is just punitive language put in out of spite because there is a movement in this country and in this Congress, unfortunately, which I call pandering populism, which just simply dislikes anything that has to do with Wall Street. Sure, they did a lot of things wrong and caused a lot of problems, but if you're going to apply the punishment for problems that occurred here fairly, we should be looking in the mirror at ourselves for a lot of things that happened in the economy, particularly forcing things on a housing market that it couldn't sustain. It's just penal. That's the purpose of this, punitive. And in the end it's going to cut off our nose to spite our face because it will be our credit that contracts and it will be our business that could be done and done in a very effective way here in the United States, not overseas.

 

What should be done here rather than this exercise, which the Fed has said, is causing a highly disruptive and costly effect on banks and their customers and having serious consequences on the competitiveness of the United States? Remember, we are competing in the world. That may have escaped the attention of the Agriculture Committee when they wrote this language, but we are in a world competition and derivatives are not a uniquely American product. They are a global product. So these are jobs that go overseas, this is credit that goes overseas, this is business that goes overseas, this is Main Street that will be affected by this language.

 

How should it have been done? Well, it should have been done in a rational way, not in a punitive way. We know that the derivatives market was not transparent enough. We know that there was not enough capital, liquidity, or margin behind the products and the counterparties that were exchanging products in the derivatives markets in the over-the-counter system. We know, because we have AIG as example number one, that a tremendous amount of CDO’s were being written with nothing behind them except a name. We can fix all that and it can be fixed in a way that almost everybody is comfortable with. First, by making sure that only the products exempted from going to a clearinghouse are products which have a specific commercial use, are customized and narrow. And that the people dealing in those products are not large enough that there are systemic issues.

 

Secondly, we put everybody else on a clearinghouse. What's a clearinghouse mean? Well, it essentially means there will be a third party insurer, or holder, of the basket of assets necessary to support the derivatives contracts. So that we are fairly confident that when a trade is made on a clearinghouse, the counterparties have the liquidity and the margin behind their positions to support their trades. At the same time, the clearinghouse itself must be structured in a way that it has adequate capital. And where's that capital going to come from? It can only come from one place; really, it comes from the people who trade in these instruments. They're going to have to put up the capital.

 

And the regulators – SEC and CFTC – will have direct access to controlling and making sure that that capital is adequate in the clearinghouses and making sure that the clearinghouses are adequately monitoring the contracts. And then, as the contracts become more standardized, -- and they will and they can, we all accept that -- they move over to exchanges, where they're basically traded like stock and then you have absolute transparency, price disclosure and you don't have the issues of the over-the-counter market that caused so many problems for us. That will happen almost naturally, but you could have the regulator stand up and say, well, we think this group of derivatives is standardized enough and you've got to move it to an exchange. We could give that power to the regulators. That makes sense. But it would happen naturally anyway as as these clearinghouses become more effective at standardizing the products and people become more comfortable with standardized products in these areas.

 

And, of course, there would have to be real-time disclosure to the regulators of what the prices were if they are OTC prices or clearinghouse prices, so that they know what's going on. And then it would be up to the regulators to decide when that information should be disclosed to the markets, depending on how you make these markets. Sometimes you can't disclose information immediately, otherwise you wouldn't be able to make a market and you wouldn't be able to do the contracts and, therefore, you wouldn't be able to do the business which underlies the need for the derivative.

 

All of that could be done, and it does not require creating this entity or these series of entities out there which the Federal Reserve has described as impairing the financial system. You go in the direction of what is being proposed in the Agriculture Committee in the area of derivatives and set up this independent swap desk, you're not making things stronger in our financial structure. You're making them weaker. You're significantly reducing the strength of the regulatory arms that guide and oversee the derivatives, and you're also, as I mentioned earlier, creating an almost guaranteed-to-fail situation with regard to the need for capital to support these transitions. It's just makes no sense at all.

 

To begin with, derivatives are, by definition, a bank product; so the idea that they have to be spun out of banks and financial institutions is on its face absurd, really absurd. And just counterproductive to the whole purpose of using derivatives, which are very important. You know, the Congress recognizes that. In Gramm-Leach-Bliley, we call derivatives a bank product. We understood that then, but we seem to have forgotten now.

 

I have been trying to figure out what's behind this type of language, because it's so destructive to our competitiveness as a nation. As I said earlier, this is the type of thing you would have seen in Argentina in the 1950's, this virulent populist attack on entities simply because they're large and because there's a populous feeling against them. This ends up, by the way, significantly affecting Main Street in a negative way. Look at Argentina, in 1945, they were the seventh-best economy in the world. Now they're like 54th or something. It is because of this populous movement which has basically driven their ability to be competitive offshore.

 

Now we have this huge populist movement here and I'm trying to think, what is the rationale here other than just rampant pandering populism? A vote occurred in the Budget Committee last week, which I happen to be Ranking Member of, that crystallized the situation for me. Senator Sanders from Vermont, who I consider a friend and I enjoy immensely, a great guy with a great sense of humor, but we disagree on a lot of things as he runs as a socialist and I run as a conservative. Senator Sanders offered an amendment which said that the government has the right to break up large corporations.

 

The amendment did not say that we needed to break up large corporations that had problems and had overextended themselves, which everybody agrees should happen. That's what Senator Warner was talking about. He's done extraordinary work in this area, and I’m really supportive of his efforts on resolution authority where if a big bank, a big financial house or a big entity gets into trouble, where they've overextended themselves and they're essentially insolvent, then they get broken up. The taxpayer does not come in, in any way, shape, or manner, and support that entity. That's what the Warner-Corker language does. I believe the Senator from Connecticut has tried to incorporate a large amount of that. That should be our policy.

 

But what the Sanders amendment said was that any bank or any financial house could be broken up simply because it was deemed to be "big" no matter how resilient or strong it is, no matter if it is a major player for our nation, making us more competitively internationally. Now remember when an American company goes overseas, they want to use an American bank. They don't want to have to use the Credit Suisse or the Bank of Singapore. They want to use an American bank to follow them around the world and those banks have to be pretty big to do that, and some of them are quite profitable and quite strong. The Sanders language would have said, no matter how strong, profitable and robust you are, how much you contribute to the American economic system by giving us one level of financial services which we need as a country which can support large financial institutions that can support very complex, sophisticated international activity and domestic economic activity -- that they would be broken up because a group of people here in Washington didn't like them for social justice reasons. They didn't lend enough to some group that they wanted to lend to, or they lent too much money to some group they didn't want money lent to. For social reasons we'll break up this company even though this is a strong and fiscally responsible company. That was the policy proposed in the Budget Committee. Ten people voted for that policy.

 

Where does that stop? Where does this Section 106 stop? Do we break up Wal-Mart because they're non-union? Do we break up McDonald’s because they sell foods that some people think make you too fat? Do we break up Coca-Cola because they have too much sugar in their products? Does everything that’s big in this country get broken up because there is an attitude that big is bad, whether it contributes or not? Unless you happen to be big and union, in which case you get saved, as the UAW was able to work out for GM and Chrysler.

 

This language isn't about fixing the derivatives market at all. You can fix the derivatives market in a comprehensive, substantive and effective way that keeps America as the best place to create these types of products in the most sound and safe way. You can do that, as I’ve outlined pretty specifically how you would do it, without this section, which I will close by reading one more time how the Federal Reserve has defined it. It cannot be underestimated the damage that would be done to our economy were this section to be approved. “Section 106 would impair the financial stability and the strong prudential regulations of derivatives, would have serious consequences for the competitiveness of the United States financial institutions and would be highly disruptive and costly both for banks and their customers.” And, remember, their customers are the people that work on Main Street for the companies that use derivatives. And almost every company in this country of any size uses a derivative to hedge their risks.

 

Ironically, this is all done in the name of social justice because “Wall Street is bad.” Thus, we're just going to go out and cut off our nose despite our face. It is incomprehensible that a nation which has become as strong and as vibrant as we have by promoting a market economy would decide to go down this route, which is the antipathy of a market economy of but that's where we are. That's what's happening, which is unnecessary, by the way, as I said earlier, because a derivative can be made safer and sounder by simply restructuring the transparency and the manner in which derivatives are put on clearinghouses, limiting the amount of those that are subject to exemption and pushing people towards exchanges to the fullest extent possible and to the extent it will work. All of that can be done without this type of language, which is so destructive, and, as the Federal Reserve has said, will have the direct opposite effect of what it is alleged to do.

[Guest Tea Party Patriot]

The Senate Agriculture committee is considering its proposed overhaul of derivatives regulation after lobbying by Mr. Buffett's Berkshire Hathaway Inc., so he would not lose money on the legislation.

 

Why do bankers keep calling the mainstream Americans "populist?" It is a linguistic tool to make us look like just an angry mob that cannot think for themselves. The real truth is that they need Congress to make sure they still will control all our money. They will say anything and do anything to get it. But, they have no loyalty to us.

 

Warren Buffet is pushing his puppet, Nebraska Sen. Ben Nelson in the Senate Agriculture Committee, to exempt existing derivatives contracts from the proposed rules.

 

Mr. Buffet what happened to your calling derivatives "financial weapons of mass destruction?" I views change when it affects your bottom line. I would surmise that Mr. Buffet is not a fan of putting up any collateral when he gets into a contract.

 

Since Mr. Buffet owns the Washington Post, I expect the paper to craft his ideas into a news story. I could be wrong on this part. I hope they still hope they follow journalistic oath of fair reporting.

[Guest Gaucho]

Money corrupts even the best of them.

 

http://online.wsj.co...0785525128.html

 

Berkshire employees have given Mr. Nelson $75,550 over his political career, according to the Center for Responsive Politics. Mr. Nelson owned between $500,000 and $1 million in Berkshire stock at the end of 2008, according to the most recent financial disclosure forms.

 

I wonder what the gecko would say to his owner on this one.

 

Sir,

You are the richest man in the world. Can't you just do this one for all your many, many customers living in this country.